Market failure (One case: Public goods) (L8)

Is this a public good?

What do you think will happen?

  • Four undergraduates seated, each get $5 ‘endowment’
  • Told each can choose to invest none/some/all in ‘group project’


Each simultaneously puts $0-$5 in envelope (or via computer)

Experimenter collects ‘contributions’, doubles total, divides it equally among group

Consider…

Market failures - public goods, coverage

  • NS: Ch 16 – public goods section only (skip Lindahl eqiliibrium, median voter, single-peaked preferences optional)

Additional readings on private provision of a public good, Charitable giving, Information goods \(\rightarrow\) further below

Key goals of these lectures (and accompanying self-study)

  • How do economists define a public good? What fits into this category?

  • Better understand ‘market failures’

  • Be able to explain: why a competitive market will usually undersupply} a public good, but may still supply some of it

Understand (in general):

  • difficulties government faces in providing the right amount/mix of public goods


  • General patterns and evidence on voluntary provision of public goods, including in ‘lab experiments’
    • … and what are ‘lab experiments’ in Economics?


Outline: What’s a public good, why do markets provide these sub-optimally, (how) can governments provide these optimally, when do people provide them voluntarily?

Market failures

… Occur when prices don’t fully reflect the marginal social benefits or costs

  • May provide scope for political intervention

  • How does this happen?

  • One potential source of market failure: Public Goods

Public Goods (attributes, categories)

Public Goods (attributes, categories)

What are the characteristics of a public good?

Def – A Pure Public Good is a good that is both

  1. Non-excludable: Once the good is provided, it is impossible/costly to prevent any individual from using/benefiting from it.
  1. Non-rival: One person’s consumption doesn’t reduce the quantity available for others.

  • The fact that some people use the good doesn’t prevent others from using the same good.

  • There is no ‘crowding.’

  • Provision/consumption to additional users at zero marginal (social) cost.

In between’s (self-study)

Excludable and rival (depleatable)? \(\rightarrow\) Private good


‘Club goods’: excludable but non-rivalrous (at least up to a congestion point).


“Common property”: Nonexcludable but rivalrous



‘Somewhat’ nonexcludable and/or ‘somewhat’ nonrival: –> ‘impure public goods.’

What about?

  • Recorded music
  • ‘Information’ goods (e.g., software)
  • A national park
  • A theatre performance
  • Roads
  • Clean air
  • Education
  • Aid to the needy

What about?

  • Loud music coming from my window
  • Disease control
  • Economic research
  • The justice system
  • Fireworks in Disney World
  • The 2012 Olympics in London

The basic ideas

If a good is non-rival then additional provision (of the units produced, to more consumers) is costless.

Thus,

  • if exclusion is possible, and any positive price is charged, some are deterred from consuming it
  • this is inefficient: people who could benefit from the good, at no cost to others, will not consume it :(

And…

(If non-rival)

Even if each person provided it for their own benefit (on the assumption that no one else would), they would typically choose too little from a social POV…



Considering their own marginal benefits (and MRS) versus the price or cost, not the social marginal benefit (an ‘externality’ to them)

If a good is non-excludable it will be difficult to charge people for it

  • many will prefer to wait for others to buy it, and then they enjoy it anyways (free-ride) (that’s a ‘coordination problem’)


But if firms cannot charge for its full value, they might not pay the fixed costs to develop/build/provide it


Who would pay to produce a film that is freely pirated/distributed? Who would pay to develop a drug that must be priced at its marginal cost? Why contribute to police protection for your village, if your neighbours will pay for it anyways?

Motivation

Policy: ‘Public goods argument’ - justifies many government programmes (military, environmental cleanup, research, etc)



Management: Companies/individuals can only profit (or even cover costs) from providing a public good through ???

…gaining subsidies, helping others avoid enforcement (fines) or ???

gaining voluntary support … or ??

by turning it into a private (or excludable) good.

Application: drug development (self-study)

Drug R&D may be a public good, or a common resource

Expensive to develop and introduce a new drug – ‘sunk costs’ once developed

But cheap to copy and produce; without patent protection may have \(P=mc\) and no ex-post profit to compensate for sunk costs



\(\rightarrow\) No incentive to develop drugs without patent protection guaranteeing ‘excludability’ and a limited monopoly

(…drug development)



But ex-post, patent protection is costly; drug produced for a few pennies, sold for 1000’s

  • People may not buy, or NHS may not cover


\(\rightarrow\) Inefficient: some consumers may value drug at 100’s, far above MC, yet they don’t consume it


Possible solution: Government awards and subsidies for drug development.

Public Goods and Market Failure

Public Goods and Market Failure

The First Welfare Theorem’s assumptions/conditions do not apply to public goods. Markets do not yield a Pareto Optimal outcome.



  • Non-excludability \(\rightarrow\) coordination problems \(\rightarrow\) no price or suboptimal price \(\rightarrow\) firms don’t get the correct signals for production


  • Non-rivalry \(\rightarrow\) each unit provides benefit to all, consumer choices don’t reflect this\(\rightarrow\) firms don’t get correct signals

Social benefit of a private good vs a public good

  • Overall value of a private good: (area under the) ‘horizontal sum’ of individual marginal benefit curves

    • Because ‘only one person consumes each unit’



  • Public goods: ‘everyone consumes the same unit’

\(\rightarrow\) aggregate value, thus ‘social marginal benefit’ of public good sums vertically

MOVE to powerpoint here

With a binary choice (provide or don’t) it is a ‘Prisoner’s Dilemma’:

Discussion breakout (time-permitting)

3-5 minutes



Partner in groups of 2-3 with the person on your right/left. Can you agree on and explain in simple language?

  1. What is a public good? What do we call a good with only 1 of these 2 necessary properties?

  2. Why does the free market underprovide these? Why/when do they provide some amount?

2 minute exercise - partner in groups of 2-3

  1. What is an example of a public good, perhaps one from your own life that we didn’t already mention

  2. What are some things you think may lead to more voluntary provision of public goods?

Solutions to the Public Goods Problem

Solutions to the Public Goods Problem

(Skip: Lindahl equilibrium)

Government’s role

Pure public goods not provided optimally by free market, i.e., voluntarily

  • although people do contribute to public goods, e.g., making charitable donations, for various reasons

A justification for government: to enforce contributions to public goods, and make everyone better off


  • But it’s hard to determine tastes for the public good, hence difficult to determine the optimal level!

Revealing the Demand for Public Goods (brief)

Suppose some people like fireworks, and some don’t. How many should the town pay for?


  1. Ask everyone to state the number of fireworks they want, and we choose the average and split costs evenly? Would this work?

\(\rightarrow\) Fireworks-lovers may overstate their value to skew the average.


  1. Ask everyone to state number they want; choose average; those who stated more pay more?

\(\rightarrow\) Many people understate their value to avoid having to pay. Doh!

Thus:



Difficult or impossible to find a ‘mechanism’ that leads to ‘truth-telling’


Direct voting on each proposal also may not lead to the optimal choice

Voting paradox example

Red: None \(\succ\) Soft \(\succ\) Hard

Blue: Soft \(\succ\) Hard \(\succ\) None

Purple: Hard \(\succ\) None \(\succ\) Soft

  • Suppose we elect a parliament with equal shares of each (representing equal-sized constituencies).

Which proposal would win if they voted on:

  • Hard vs Soft?
  • Soft vs None?
  • None vs Hard

Does a majority vote reveal a clear ‘social preference’?

No, not here.

Lab evidence on voluntary provision of Public Goods

Lab evidence on voluntary provision of Public Goods

Typical ‘Public Goods Experiment’

  • Four undergraduates seated, each get $5 ‘endowment’
  • Told each can choose to invest none/some/all in ‘group project’




Each simultaneously puts $0-$5 in envelope (or via computer)

Experimenter collects ‘contributions’, doubles total, divides it equally among group

My private benefit from this ‘public good’ = \(\frac{1}{2}\) of total contributions, so I only get back half of my own contribution

We say the ‘marginal per capita return’ \((MPCR=1/2)\)

Basic results

  • On average, subjects contribute halfway between everything and nothing



  • Contributions decline with repetition, but not to zero



  • Face to face communication improves the rate of contribution

Today I learned (‘TIL’)

  • What is a pure public good (nonrival, nonexcludable), some examples, variations
  • Why do markets fail to provide these optimally; private versus social marginal benefit
  • Obstacles to government’s optimal provision (how do we know how much to provide?)
  • General patterns on ‘public goods provision in laboratory Economics experiments’

Exam-type questions

… (2018 exam)

Supplementary readings

  • Ledyard, J.O., 1993. Public Goods: A Survey of Experimental Research, Division of the Humanities and Social Sciences, California Institute of Technology.

  • Chaudhuri, 2011. Sustaining cooperation in laboratory public goods experiments: a selective survey of the literature

    • Or any more recent survey!

  • Vesterlund, Lise. “Voluntary giving to public goods: moving beyond the linear VCM.” Handbook of Experimental Economics 2 (2012).

  • Varian, Hal R. “Buying, sharing and renting information goods.” The Journal of Industrial Economics 48.4 (2000): 473-488.

    • Any updates to this?

Alternate focus: charitable giving, supplementary survey and handbook articles

See my page: innovationsinfundraising.org

I’d love to have your feedback on this

Survey and handbook articles

Andreoni and Payne (2013). Chapter 1 ‘Charitable Giving’ in Auerbach, Alan J., et al., eds. Handbook of public economics. Vol. 5. Newnes, 2013.

List (2011). Econ Perspectives or List (2008, ExpEcon), ’Introduction to field experiments in economics with applications to the economics of charity

Andreoni (2006), ‘Philanthropy’ in Handbook of Giving, Reciprocity and Altruism; Andreoni (2005). ‘Charitable Giving’

Bekkers and Wiepking, esp ‘Part 2: why do people give’

Sargent and Woodliffe;

Duncan (2004); Atkinson (2008); List (2011, JEPR)

Non-academic accounts: Behavioural Insights Team (2013), ‘Applying Behavioural Insights to Charitable Giving.’ (Semi-academic)

Public Goods games … understand

  • Understanding of the PG game/VCM and the theory behind it
  • Its variations and terminology (e.g., ‘MPCR’, ‘stranger-matching’, ‘endgame’, ‘punishment’)
  • Methodological issues
  • Patterns of contributions in VCMs
  • Some things repeatedly found to increase contributions in VCMs
  • Relation to field evidence

Charitable giving … understand

  • Can it be modeled as a contribution to a public good?
    • What are the ‘puzzles’ in this modeling
    • What is meant by ‘warm glow’ giving and ‘impure altruism’?
    • What are other models and motivators of charitable giving
  • Some evidence on things that increase donations

Information goods … understand

  • When and why these may have characteristics of Public Goods

  • How firms may profit from selling information goods, and when this may be less than efficient

  • Government intervention and potential policy improvements in these markets